Dividend Funds vs Growth Funds: Key differences and which is better?

Mutual funds are investment vehicles that pool money from multiple investors to invest in various asset classes like stocks, bonds, etc. Based on the investment objective, mutual funds can be categorised into equity funds, debt funds, hybrid funds, solution-oriented schemes, and other schemes.

Equity mutual funds invest predominantly in equities or stocks. They can be further classified into types of options: growth option and dividend option based on the treatment of earnings from the fund's portfolio.

Read on to understand the differences between dividend option and growth option in mutual funds.

• Table of contents

• Growth option in mutual funds definition
• Dividend option in mutual funds definition
• Growth vs dividend in mutual funds
• Benefits of growth option in mutual fund
• Benefits of dividend option in mutual funds
• Tax implications on growth vs dividend mutual funds

Growth option in mutual funds definition

Growth option in equity mutual funds aim to provide capital appreciation to investors over the long term. The fund manager invests in shares of companies that have potential for high growth.

Moreover, the earnings from the stocks held in the fund's portfolio are not distributed as dividend payouts. Instead, the fund reinvests the earnings back into the portfolio to fuel further growth. This helps the fund's Net Asset Value (NAV) to rise over time and generate potentially favourable returns for unit holders.

Since there are no dividend payouts, investors can benefit from the power of compounding in growth option. The reinvested earnings can generate additional earnings, allowing the investment corpus to grow exponentially over long periods.

Growth option suits investors who have a long investment horizon and aim to build wealth by capital appreciation. The fund's performance is measured by the growth in its NAV.

Dividend option in mutual funds definition

Dividend option in equity mutual funds distribute a portion of the earnings from the fund's holdings to investors in the form of dividends.

The dividend amount is paid out from the fund's realised profits and surplus cash. It represents the share of earnings for the unit holders. The dividend income or the IDCW (Income Distribution cum Capital Withdrawal) received from portfolio stocks is passed on to investors after deducting fund expenses.

The dividend amount declared by the fund reduces its NAV by the same extent. So, the NAV falls to the extent of dividend payouts.

Dividend option suits investors looking for income in the form of dividends besides long-term capital appreciation. The fund's performance is measured by dividend yield and NAV growth.

Read Also: Dividends Guide: Key Types & Significance for Investors

Growth vs dividend in mutual funds

Here are the key parameters based on which growth and dividend in mutual funds differ.

1. Investment objective
   • Growth option aims for capital appreciation and wealth creation over the long term.
   • Dividend option aims to provide income through dividends besides long-term capital gains.
2. Treatment of earnings
   • Growth option reinvests earnings back into the fund to fuel further growth.
   • Dividend option distributes surplus earnings as dividend payouts to investors.
3. Ideal investment horizon
   • Growth option may require an investment horizon of 5 years or more.
   • Dividend option may be held for 3 years or more.
4. Performance measurement
   • Growth option in mutual funds is measured by NAV appreciation and capital gains.
   • Dividend option in mutual funds is measured by dividend yield and NAV growth.

Benefits of growth option in mutual fund

Here are some key benefits of investing in growth option in mutual funds.

1. Wealth creation through capital appreciation

Growth option aim to deliver relatively reasonable returns by investing in high growth companies. The power of compounding allows wealth to grow exponentially over a long tenure.

2. No tax liability on earnings

Earnings are reinvested back into the fund. So, investors don't have to pay any tax until units are redeemed.

3. Benefit from rupee cost averaging

Reinvested earnings can be used to acquire more units when the market declines. This brings down the average cost of acquisition.

4. Flexibility of withdrawal

Investors can redeem units anytime as most growth options do not have an exit load or lock-in period.

5. Low portfolio churn

Fund manager adopts a buy-and-hold strategy to benefit from long-term returns. This results in lower portfolio turnover and cost.

6. Suits aggressive investors

Growth options are suitable for investors willing to take higher risk in pursuit of higher returns over the long run.

Read Also: Ex-dividend date: Meaning, essential milestones, and examples

Benefits of dividend option in mutual funds

1. Income

Dividend payouts offer investors income besides capital appreciation. This provides cash flows to meet expenses.

2. Relatively lower volatility

Mature companies with stable cash flows exhibit lower volatility compared to growth stocks. This reduces risk.

3. Reinvestment option

Unit holders can opt to reinvest the dividends to benefit from compounding.

4. Transparency

Dividend payouts act as a signal of the fund's performance and earnings generated.

5. Suits conservative investors

Dividend option suits investors with moderate risk appetite aiming for regular income and moderate capital gains.

Tax implications on growth vs dividend mutual funds

In growth option, long term capital gains above Rs. 1.25 lakh are taxed at 12.5% without indexation. Short term gains under 1 year are taxed at 20%. Dividends from mutual funds are now taxable in the hands of investors at their applicable income tax slab rates.

Switching from dividend to growth option or vice versa has tax implications. The NAV difference is treated as capital gains or loss. Dividend payouts reduce mutual fund NAVs. So, investors have to pay capital gains tax on the reduced cost.

Conclusion

Growth option is suitable for investors focused on wealth creation through long-term capital appreciation. Dividend option can be suitable for investors seeking regular income through dividends besides moderate capital gains.

The choice between growth and dividend option should be based on investment goals, risk appetite and tax considerations. Investors must evaluate both options before selecting the right fit for their portfolio.

FAQs:

How to choose between growth and dividend option in mutual funds?

Consider investment horizon, goals, risk tolerance and tax liability. Growth funds suit long-term aggressive investors. Dividend option in funds suit short- to medium-term conservative investors seeking regular income.

Can we switch from dividend to growth option in a mutual fund?

Yes, investors can switch between dividend and growth plans within the same scheme. NAV difference on the switch date is subject to capital gains/loss.

Is dividend income on mutual funds taxable?

Dividends from mutual funds are taxable in the hands of investors. The Dividend Distribution Tax (DDT) regime was abolished by the Finance Act, 2020. Now, any dividend income received from mutual funds must be added to your total income and is taxed at your applicable income tax slab rate.

Can I invest in both dividend and growth option mutual funds?

Yes, one can invest in a mix of growth and dividend funds to meet dual goals of long-term growth and income. Maintain proper asset allocation based on risk appetite.

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